WaterNSW believes mining operations in Wollondilly should be restricted to protect the state's water supply.
The state-owned organisation wants a curb placed on future mining at South32's Dendrobium Mine at Appin and Peabody Coal's Metropolitan Mine due to "millions of litres of water being lost daily" as a result of mining operations across the state.
WaterNSW made the recommendation in its submission to the Independent Expert Panel for Mining in the Catchment.
The panel was established to provide advice to the Department of Planning and Environment (DPE) on the impact of mining activities on the quantity of water in the Sydney catchment area.
Mayor Matthew Deeth said the council welcomed WaterNSW's recommendations.
"I am afraid that the state government is heading towards potential disaster where Sydney and Wollondilly's water supply is compromised," he said.
"The protection of water supplies and overall management of the catchment is paramount if we are to ensure its supply for our community and our future generations."
One of Wollondilly's most iconic natural waterways, Thirlmere Lakes, has been slowly shrinking over the past decade.
Friends of Thirlmere Lakes member David Hunt said the three main lakes were now completely dry apart from a few puddles.
He said said mining drainage was the primary cause of the lake's low water levels.
"The pumps at the mines [need to be stopped] to allow the water table to recover," he said.
"The mines, even when operations are suspended, continue pumping [water from the lakes]."
A scientific study funded by the government is currently under way to investigate the loss of water at Thirlmere Lakes.
Wollondilly Council supported the creation of the Independent Expert Panel last year to obtain scientific evidence of the impacts of mining operations on both the quality and quantity of water sources within the catchment and to address community concerns regarding this matter.
"We have received a strong level of feedback from the Wollondilly community as it directly impacts our drinking water supply," Cr Deeth said.
"The council will continue advocating on these community concerns to both the panel and government."
Cr Deeth said the panel was expected to release a report on the impacts of mining on water quantity.
"Council looks forward to the public release of this report," he said.
NSW Greens MP and environment spokeswoman Cate Faehrmann has also called on the government to revoke recent approvals for more underground coal mining in Sydney's water catchment area due to WaterNSW's findings.
"You can't get a stronger submission from a government agency than this," she said.
"Clearly, if Water NSW could ban mining in our water catchments it would.
"Sydney's dams are dropping at the rate of 0.5 per cent per week and will be just at 50 per cent in a little over a month's time.
"It's time the security of Sydney's drinking water is put ahead of mining interests."